Polymetal International Plc - Dividend Growth Model - Assignment Example

Assessment 2

Task 1

In this document, a critical analysis of the share movement of “Polymetal International PLC” during the period January 2016 to April 2016 is conducted. Efficient Market Hypothesis is utilized to track the movement of share prices of the company.

The Efficient Market Hypothesis is an investment theory that states that the value of the company in the share market is reflected through its share prices. Efficiency Market Hypothesis is focused on the idea that the stock of the company is traded at its fair value in the stock market. Hence, the valuation reflected through the share price cannot be undervalue/overvalue, but it rather emphasizes that the share sold or purchased in the stock market is based on the actual value of the stock. Under this theory, it is explained that the predictions for future market price cannot be a way to determine profit generation but the prices can only be predicted to fluctuate if new information enters the market. It highlights that the change in share prices is valued on the basis of the new information. Harder (2015) explains that valuation of share in an efficient market is actually determined on the basis of competition and how readily the competitors respond to the new information available in the market.

Polymetal International PLC is a metal mining company that is engaged in the extracting of precious metal mining in Kazakhstan and Russia. The company has operations in different countries across the globe that explore various mining products such as coal, platinum, gold, silver, and copper for metal companies. Currently, Polymetal International has licensing of over 79 countries and extracts metal from approximately 9,000 square kilometres.

Source: Yahoo Finance

From the data, it can be noted the share price of Polymetal International PLC has fluctuated during the period (January 2016 to April 2016). There is an inclining trend in the share prices of Polymetal International Plc. from 18 January 2016 onwards. The information revealed in the market shows that Polymetal is doing better than other mining companies because of its focus on gold mining. The investors continue to buy gold because of the prevailing sector that depict that the gold standards will be higher than other precious metals. Due to this news and expansion in the company’s licensing it has led to a significant increase in the share price of Polymetal. There news disclosed in the market related to the increase in the license has influenced the share price of the company. There is a drop in the share price of Polymetal from 22 March 2016 that again became steady after the news of increasing its authority for mining. The decline in the share price is because of the news that the company’s performance is lower than competitors in the market. On the other hand, soon after that the news on 27 March 2016 shares that the firm has effective asset management and operational efficiency of Polymetal is better than its competitors that has again led the share price to increase. Besides the fact that Poly International PLC reports regarding signing up its new deals in Kazakhstan for gold and silver. It is noted that the share price of the firm has declined. It indicates that the share price is undervalued. The news in the market related new signings of Google and McKinsey in Kazakhstan’s mines shows that the new signings of other mining companies has declined the opportunity for Polymetal International PLC to extract metal from Kazakhstan. It is noticed that the share price of the company has started to decline since 20 April 2016. The valuation of the share price of Polymetal International PLC has declined with a similar pace. In the case of Polymetal International PLC it can be identified that the efficient market hypothesis fails to explain the share price movement of the company.

Task 2

Introduction

Royal Mail Plc. is the postal services company of the United Kingdom. It was established in 1516 and operates under the name of different brand names such as International & Letter, General logistic System, UK parcel and UKPIL segments of the company offer letter and parcel services to different customers across the globe.

Net Asset Value

Net Asset Value for Royal Mail is calculated per share taking the net book value at the year-end that is divided with the number of shares outstanding. It is also known as book value per share. It informs about the share value comparing it with respect to the asset value.

Net Asset Value = Net Assets / Number of shares outstanding

Net Assets3,846

Overstatement of Assets(500)

Bad Debt (Receivables)(100)

Adjusted Net Assets3,246

Shares outstanding1000

Net Assets = 3246 / 1000

Net Assets = 3.246

From the above calculations, it can be noted that the net asset value of was 3.246. Investors make use of net asset value per share to determine the performance of the firm comparing with its benchmarks. By comparing the company’s net asset value with its share price it can be noted that it is less than the share price as on 29 March 2015 was 442p that indicates that the share price of Royal Mail is overvalued which depicts unhealthy projection of its share price. In such situation the company can repurchase its stocks at the market price to increase the net asset value. It means that the share is being traded at higher prices than its actual value in the market. Therefore, there are potential risks that the share prices projected are less than its actual value that can result in higher risks.

• Cost of Capital

WACC = Equity/(Total Capital) x Cost of Equity + Debt/(Total Capital) x Cost of Debt x (1-Tax Rate)

Cost of Equity = Re = Rf+β(Rm-Rf)

Cost of Debt = Bond Face Value x Coupon Rate / Current Price

Debt

D

1,270

1,270

Risk Free Rate

Rf

3.00%

3.00%

Coupon Rate

2.38%

2.38%

Face Value

100.00

100.00

Price

90.00

90.00

Cost of Debt

Rd

2.64%

2.64%

Return on Market (S&P 500)

6.00%

6.00%

Risk Premium

3.00%

3.00%

Tax Rate

20.00%

20.00%

Equity

E

3,846

3,846

Adjusted Equity (after Adjustments)

3,246

3,246

Equity Beta

0.0010

1.3000

Re

3.00%

6.90%

WACC =

WACC

2.75%

5.55%

The cost of capital of Royal Mail was calculated after determining the cost of equity and cost of debt for the year ended 2015. Assessing the information, it can be noted that the cost of debt for the company is 2.64 percent. The beta value shows the risk and volatility for share price. The risk free rate assumed for government securities was 3 percent and the volatility of Royal Mail stock was 0.001. The low volatility of the company’s stock implies that its share price is less likely to move with fluctuations in the market index and there is low risk associated with investment in Royal Mail stocks. It can be expected return on the stock price is 2.78 percent. Hence, it can be determined that if the investors invest in Royal Mail stock then the prices will increase. To determine the cost of financing of the company, the value of cost of debt is compared with the cost of equity that was calculated utilizing CAPM model. The calculation for the cost of equity was 3.00 percent. It indicates that the cost of equity of the company was higher than the cost of debt. Hence, it can be identified that if the Royal Mail finances its activities through debt the cost of capital will be lower. The cost of capital determined is 2.78% required by investors that would be used for valuation of projects. Low WACC implies that the company can generate funds at low cost that could help the business to increase its business and assets if it requires doing so. Considering a higher beta of 1.3, which implies higher sensitivity of the company’s stock price, the WACC is 5.55% that is higher than the WACC with lower beta. It implies that if the stock beta risk increases then the company can expect a higher return required by stakeholders.

• Dividend Growth Model

The Dividend Growth Model is used to calculate the price of a share using the assumption that the growth is 0 percent in one case and 2 percent in the second case to determine the price of a share. It enables the investor to determine the actual value of the stock and forecast it performance. In order to calculate dividend growth rate for Royal Mail Gordon Growth Model is used to value its stock. Using this growth model the investor can determine the value of stock ignoring current market conditions.

Formula for Dividend Growth Model

Price of share = Dividend / Rate of return – Expected growth rate

Dividend

0.2

0.2

Cost of Equity

3.00%

3.00%

Growth Rate

0%

2%

Price of Share

6.66

19.94

Dividend

0.2

0.2

Cost of Equity

6.90%

6.90%

Growth Rate

0%

2%

Price of Share

2.90

4.08

From the analysis, it noted that if the cost of equity is 3.00% and the growth rate is assumed at 0% then the share price should be 6.66. Comparing it with the share price of the company on May 2015 was 4.42 suggests that the stock is under-priced. This is same analysis if the growth rate is assumed at 2% and the share price calculated is 19.94. However, if the cost of equity is 6.90% and the growth rate is assumed at 0% and 2% then the share price should be 2.90 and 4.08 respectively. In this case, it could be stated that the company’s stock is overpriced in May 2015 when it traded at 4.42.

• Value per share using the price earning p/e ratio

Price earnings ratio is calculated to measure the valuation of the company comparing its share price to earnings per share. It enables the investors to look into the earning that the investor may expect assessing its share price. The high P/E ratio indicates higher earning expectation of investors making investment in the company. If the P/E is low it shows that the earnings are undervalued and are higher than the expectation of investors, which indicates higher confidence of investor.

P/E ratio =

2015

2014

Share price

4.42

5.64

EPS

0.428

0.306

2015

2014

P / E Ratio

4.42 / 0.428

5.64 / 0.306

P / E Ratio

14.44

13.18

P/E ratio tells about the share price relative to its share earnings. It is also used to calculate market value of the share. Comparing the P/E ratio of Royal Mail for 2015 and 2014 of Royal Mail it can be noted that the calculated P/E ratio is higher in 2015 and also the share is trading at higher multiples of the company’s EPS. Assessing the P/E value of Royal Mail shares on the basis of the calculation it can be noted that the investors expectation for return is higher. Seeing the P/E value for the year 2014, it can be noted that the P/E ratio is 13.18. It indicates that the investors expect to earn higher returns in times to come, as the share value for the company in 2014 was 5.64. However, the share price felt to 4.42 in 2015. It can be noted that the PE is at higher multiples in 2015 and the shareholders can expect further increase in the price if the company continues to perform well otherwise the investors may lose their confidence in the company.

Part B Comment on the value of a Royal Mail share and advise your client

On the basis of the calculation, it can be noted that the Royal Mail share value is overvalued if we look at the net asset value of the company. However, the information related to its share indicates that the performance of share is market efficient that can be reflected through the information available. Moreover, it can also be identified that investors expect higher returns investing in the stock of Royal Mail if the beta value is considered higher. Lower beta value reflects that there is low risk and volatility in the market, which indicates that there are lesser risks for the share price of the company to fall and shareholders may require a low price for it. However, the cost of debt is lower than the cost of equity that indicates that if the Royal Mail takes debts to finance its activities rather than its equity it may lower down the cost of capital for the company. However, the share price of Royal Mail at lower cost of equity is undervalued and at higher cost of equity it is overvalued. Hence, it is projected that there will be higher returns if the company will experience higher returns on its assets. On the basis of calculations, it is projected that the investment in the stock of Royal Mail will be profitable for investors if the stocks are held for longer period of time. There is a predicted decline in the share prices because of the market conditions. Based on the market positioning of the company it is predicted that the investment in the share of Royal Mail would be beneficial for investors due to which it is recommended to investors to make investment in Royal Mail share for longer period of time.

Conclusion

From the analysis provided above, it could be concluded that Royal Mail has strong market indicators and based on the assessment of the company’s position in the UK investors can gain from the holding of the company’s shares.